Lotta handwringing today about the demise of Chevron, and I can’t begin to predict the ultimate fallout, but from the narrow perspective of securities, it doesn’t feel like it’s played much of a role in some time. 

Case in point: The Fifth Circuit’s recent decision striking down SEC rules governing private investment funds.

As the court notes, for a long time, private investment companies and their advisers were exempt from Investment Company Act/Investment Advisors Act regulation.  However, in 2010, Dodd Frank amended the IAA to require that even private fund advisers register with the SEC, and make and disseminate reports according to SEC rule.  The reports required must include, among other things, information on “valuation policies and practices of the fund;… side arrangements or side letters, whereby certain investors in a fund obtain more favorable rights or entitlements than other investors.”

As part of those amendments, Dodd-Frank made another statutory change.  Prior to Dodd-Frank, there existed 15 U.S.C. §80b-11, titled “Rules, regulations, and orders of Commission,” which broadly gave the SEC the power to “make, issue, amend, and rescind such rules and regulations and such orders as are necessary or appropriate to the exercise of the functions and powers conferred upon the Commission elsewhere in this subchapter.”

Dodd-Frank added a new subsection, 211(h), which provides:

The Commission shall—

(1) facilitate the provision of simple and clear disclosures to investors regarding the terms of their relationships with brokers, dealers, and investment advisers, including any material conflicts of interest; and

(2) examine and, where appropriate, promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.

Relying on its authority under 211(h), the SEC promulgated the private fund adviser rules, which, among other things, required disclosure to fund investors of any preferential treatment given to other investors, required quarterly financial disclosures, and required fairness opinions for continuation funds.

Now, one can argue with the wisdom of the SEC’s approach – here are some papers that do just that – but you’d think the rules would at least be within the SEC’s power to “facilitate the provision of simple and clear disclosures to investors regarding the terms of their relationships with brokers, dealers, and investment advisers, including any material conflicts of interest; and … promulgate rules prohibiting or restricting certain sales practices, conflicts of interest, and compensation schemes for brokers, dealers, and investment advisers that the Commission deems contrary to the public interest and the protection of investors.”

But you would be wrong, at least according to the Fifth Circuit.

The Fifth Circuit recognized that “at first blush” the text of 211(h) would seem to authorize the rules, but immediately pivoted to holding that the language could not “be construed in a vacuum.”

What was missing, then?   If you look at the actual text of Dodd Frank – that is, the full 800-odd page bill – you see that the provisions providing for private fund registration are in a separate section than the amendments that added 211(h).  And the amendments that added 211(h) are part of a larger subsection that largely deals with retail customers (including statutory amendments that specifically reference “retail customers”).

So, concluded the Fifth Circuit, even though the text of 211(h) makes no reference to retail, even though Congress specifically named retail when making changes to the statute aimed at retail, even though many of the new private fund rules were aimed at practices (like side letters and valuation) specifically singled out by Congress when requiring private fund registration, because the 211(h) catch-all power granting the SEC authority to protect investors – in the statutory section titled “Rules, regulations, and orders of Commission” – is in a section of the 800-odd page bill dealing with retail, that meant 211(h) only granted the SEC authority to regulate relationships with retail customers.

Nowhere, of course, did the Fifth Circuit cite Chevron, or even accord any pretense of deferring to the SEC’s interpretation of the actual words of the statute (which even the Fifth Circuit agrees “at first blush” authorizes the private fund rules) – and the SEC, presumably anticipating the futility, did not even cite Chevron in its briefing.

Anyway, the upshot here is that we’ve been living in a post-Chevron, post-deference world for sec reg for quite some time.  And it’s a world where the SEC can’t engage in even the most pedestrian rulemaking.